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Schwab Reiterated at Neutral

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We have reaffirmed our long-term ‘Neutral’ recommendation on Charles Schwab Corporation (SCHW - Analyst Report), based on its third quarter results, synergies from the acquisitions and a stable capital position. However, we remain concerned about the company’s financials, which continue to be impacted by lower trading activities, unstable equity markets and volatile interest rates.

Schwab’s third quarter 2012 earnings were slightly ahead of the Zacks Consensus Estimate. Growth in asset management and administration fees along with balance sheet restructuring actions was among the positives. Yet, higher operating expenses, increased provision for loan losses, lower net interest income and subdued trading revenue were the primary dampeners.

Diversified revenue streams remain Schwab’s foremost strength. In October 2012, the company further diversified its revenue base by announcing a deal to acquire ThomasPartners, a dividend income-focused asset management firm. We believe the company’s results would continue to benefit from management’s aggressive efforts to increase clients in advisory solutions.

Further, Schwab has been making significant efforts to become less dependent on interest rates. As part of this effort, the company has announced the launch of certain initiatives, which would help augment revenue going forward, with or without a Fed rate hike. We believe that the success of these programs will enable Schwab to strengthen its position in institutional and retail businesses.

On the flip side, though Schwab is taking initiatives to strengthen its client–advisor relationship, it is experiencing a pressure on DARTs (Daily Average Revenue Trades) as a result of a disengagement of retail traders, almost similar to its peer E*TRADE Financial Corporation (ETFC - Analyst Report). We anticipate a declining trend in DARTs to linger in the near-to-mid term mainly due to lower trading activity and flattish market performance.

Moreover, Schwab’s business model is highly sensitive to interest rates. Low rates have been a drag on the company's revenue. Until the economic recovery gains momentum and interest rates significantly improve, the company will continue to experience pressure on its net interest margin and top line.

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